Thoughts on Brexit

There is a lot of uncertainty on how Brexit will play out.   The UK government is now rudderless, as is the main opposition party.  Technically, it appears that the UK government does not have to follow through on Brexit or could call another referendum.   But, both possibilities are said to be long shots.  This uncertainty is clearly a negative for global stocks and for Sterling and the Euro.  But, all the markets can shift suddenly if there are any developments that clarify the situation.

There are three consequences of the situation that deserve attention:

1.  The drop in the British Pound shows that the UK was benefiting from being a part of the EU.  British people were able to buy imports at lower prices when the Pound was being pulled up by its association with the EU.  Being a part of the EU gave the UK benefits, such as ease of access to other markets.  Ending this association means the UK has to work harder to maintain the same standard of living as before.  The drop in the Pound boosts import prices, thereby lifting inflation and depressing UK purchasing power and real incomes.  The drop in the Pound should eventually lift exports and cut imports, but this entails increased UK production.   So, the UK has to work harder to get back to the same level of real spending as before.

2.   The desire to restrict immigration -- apparently important to those who voted for Brexit -- would be another channel boosting inflation.  A smaller labor force should result in higher wages, which would likely be passed through to prices.

3.  The loss in purchasing power from higher import prices will likely hurt lower-income UK people -- who voted for Brexit -- more than higher-income people, as the former likely spend a greater share of their income on imported goods than do the latter. 

These consequences would likely follow any shift away from globalization in the US, as well.  While much political rhetoric in the US focuses on job losses stemming from trade agreements, there is little, if any, mention of the resulting lower prices and increased purchasing power, which benefit everyone.